China economy shows strain, policy shift eyed

By IBT Staff Reporter On 02/10/12 AT 7:32 AM

China betrayed signs of spluttering domestic demand on Friday as imports crumbling to their lowest in more than two years and weaker-than-forecast bank lending signalled to investors that policymakers would soon make a fresh bid to bolster growth.

China's economic expansion struck a 2- year low of 8.9 percent in the last three months of 2011, extending a steady slowdown that had prompted the government in the autumn to switch policy settings to support growth. It has gently eased monetary and fiscal conditions since.

Now more is needed.

I think that liquidity conditions are too restrictive. The economy is slowing down and liquidity conditions are restrictive, said Yao Wei, China economist at Societe Generale in Hong Kong.

A fall of 15.3 percent in imports in January compared with January 2011 was the lowest reading since August 2009, while exports fell 0.5 percent over the same period, the worst showing since November 2009, customs data showed on Friday.

That was followed by data from the People's Bank of China showing that new lending was less than 75 percent of the level expected -- a big surprise for a financial system that typically sees its biggest lending splurge of the year in January.

That supports our view that there should be more RRR cuts, said Kevin Lai, an economist at Daiwa in Hong Kong, referring to the bank reserve requirement ratio. A cut in reserves would release cash into the economy.

We expect there should be four this year, so we expect the next one very soon, Lai said.

The combination of data points raises numerous worries even though Lunar New Year holidays fell in January, which can make it difficult to interpret economic figures.

First, that the domestic demand which has shielded the world's second-largest economy from slackening exports is not as resilient as thought. Second, that China's ability to support a frail global economy by absorbing more imports is undermined.

And third, that weaker-than-expected lending is a function of banks being at their limit of credit creation, meaning the central bank will need to expand the range of policy tools beyond cuts in the reserve requirement ratio and use of open market operations if it is to effectively boost the supply of credit.

The trade data, especially imports, show that domestic demand is slowing quite rapidly. But the lending data is more indicative of that right now, the capacity to ease liquidity conditions is not as great as people thought, said Yao.

Right now the binding constraint is not the required reserve ratio, but the loan-to-deposit ratio.

GRAPHIC: China trade data http://link.reuters.com/ked55s

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Lunar New Year distortions will make policymakers wary of any hasty reaction. Most analysts expect them to assess January and February data combined before deciding whether the current policy of gentle easing should be intensified.

The week-long Lunar New Year holiday, which fell in January this year and in February last year, typically sees factories shut or run at half speed during the period.

But seasonal factors alone do not convince every economist that January is a one-off distortion, especially for trade.

A fall of over 15 percent in January cannot be entirely explained by the Lunar calendar, and adds weight to the view that economic output is slower than headline indicators might suggest, said Ren Xianfeng, an economist at IHS Global in Beijing.

Exports to the European Union, China's top export market, fell 3.2 percent in January from a year earlier, the first decline since February last year, the data shows.

Exports to the United States rose 5.5 percent in January from a year earlier, slowing from December's 11.9 percent rise and marking the weakest pace since February last year.

The big imports drop combined with a smaller exports drop left China with a trade surplus of $27.3 billion (17.2 billion pounds) in January, its biggest in six months and confounding expectations of a further narrowing.

Realisation that January would produce a bigger trade surplus may well have held the central bank back from reducing the RRR that month, when many economists had expected a cut.

It cut bank reserves by 50 basis points to 21 percent on Dec 5, a move economists believe was a response to rare capital outflows from China in the fourth quarter of 2011.

So broad M2 money supply growth of 12.4 percent in January -- the slackest pace of expansion since May 2001 -- has reignited expectations that the central bank will seek to boost credit before long.

The weak data may reflect the softening lending demand from the real economy, which is slowing down on slackening demand at both home and abroad, said Jiang Chao, analyst at Guotai Junan Securities in Shanghai.

But we cannot ignore the uncertainties stemming from the Chinese New Year effect and should better wait for the February data to call it a trend.

EXTERNAL UNCERTAINTY

Other figures on Friday showed China's current account surplus shrank in 2011, offering Beijing fresh evidence to show critics of its currency policy that it is relying less on external demand.

Chinese leaders can point to the figures next week at a summit with European Union officials in Beijing, as can Vice-President Xi Jinping, widely expected to be China's next leader, who visits Washington on Tuesday.

Xi is likely to hear calls in the United States next week that Beijing allow the currency to rise at a faster rate. The EU is also likely to make such calls when it meets China's leaders.

However, a Reuters poll this month suggested such hopes may be dashed. It showed that China is expected to slow the pace of yuan gains to help exporters cope with the slowdown in global demand growth.

China's economic growth slowed steadily throughout 2011. But the slope of the slowdown was shallow enough for the consensus to emerge that a hard economic landing will be avoided, even though many private-sector economists forecast that 2012 will see the slowest pace of expansion in a decade.

The first quarter of 2012 is widely expected to mark the bottom of China's economic downswing. Signs from the most recent purchasing managers index survey showed a slight expansion of the factory sector in January.

And analysts are wary about forecasting a cut in the RRR too soon, since data on Thursday showed annual inflation spiked to a consensus-busting 4.5 percent in January.

Taken at face value, today's trade data should push policy makers to loosen policy further. This may well happen if February year-on-year exports data is still as low but we believe there will be a large rebound to double-digit levels, Yu Song, China economist at Goldman Sachs, said in a note to clients.

Zheng Yuesheng, statistics chief with the customs administration, told state radio such a rebound was likely.

Exports and imports in February, before seasonal adjustment, will see a sharp rise, Zheng was quoted as saying.